Central banks to press on with easing

Fund Strategy - 25 Jun 2012 | By Gary Jackson

Last week, the Federal Reserve boosted Operation Twist - the selling of short-term Treasury bonds and pur­chasing of long-term securities - by $267 billion (£170 billion) and extended it to the end of the year.

This followed China’s recent surprise cut in the benchmark one-year interest rate, apparently to stimulate growth in the world’s second largest economy.

Meanwhile, speculation mounted that the Bank of England (BoE) will extend its quant­itative easing (QE) programme in July, while Japan’s central bank said it was prepared to take “bold” action if necessary.

But these moves come against a backdrop of subdued business and consumer confidence, which threatens to offset any potential positives of mon­etary policy action. (News analysis continues below)

On June 20, the Fed’s Federal Open Market Committee (FOMC) extended Operation Twist, which aims to push down long-term bond yields, as it cut its official forecast for America’s growth this year.

The Fed now expects the economy to grow by 1.9% to 2.4% in 2012, down from its previous forecast range of 2.4% to 2.9%.

Douglas Roberts, the chief international economist at Standard Life Investments, says Twist has only been a “marginal positive” so far and forcing down interest rates is not enough to stimulate the real economy.

Roberts says employment trends in America suggest businesses are holding back on recruitment but not actually dismissing workers. Similarly, consumers are reluctant to go on spending sprees that could aid growth.

“Central banks can, to some extent, create the conditions for something to happen but they can’t make them happen. They can manipulate interest rates lower but they can’t make people borrow,” Roberts explains.

Trading activity before the FOMC’s announcement suggested the market expected a third round of QE. While the Fed held back on this, it could be ­keeping its powder dry to see how growth looks in the coming months.

Ben Bernanke, the chairman of the central bank, said: “Additional asset purchases would be among the things we would consider if we needed to take further measures to strengthen the economy.”

The Bank of England could also increase its QE programme. The minutes of the Bank’s Monetary Policy Committee meeting in June showed that four of its nine members voted for additional QE, in­cluding Mervyn King, the governor.

Since the meeting, chang­ing factors have added weight to the argument for more easing in Britain. Growth continues to stall, exacerbated by turmoil in the eurozone, while inflation fell from 3% in April to 2.8% in May.

Howard Archer, the chief UK and European economist at IHS Global Insight, says: “We suspect the latest developments are likely to prod at least one more MPC member into favouring more QE in July and expect a £50 billion portion to be announced.”

Vicky Redwood, the chief UK economist at Capital Economics, also expects QE to be expanded by £50 billion next month, but she says: “There are question marks over how much good this will do.

“We would not be surpris­ed if the committee returns to the other policy options further ahead - and also widens the scope of its asset purchase programme.”

The institution that could do the most to stabilise the global financial system - the European Central Bank (ECB) - is also under pressure to act.

The International Monetary Fund last week said the ECB can support the eurozone through further “non-standard measures”, such as more long-term refinancing operations or the introduction of some form of QE.

Despite the lack of certainty in the efficacy of central bank action, Roberts expects the major institutions to continue to ease policy during the months ahead.

“It would be very difficult for them to say ’we can’t do anything’,” he says.

“If the central banks look like they are doing something… that is probably positive for sentiment and may have a spill-over effect in the real economy.”

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